The Board of Directors and the A Rational Stragey for Remaining on the Board

We are in the middle of the annual meeting cycle.  Most public companies are sending around proxy materials and seeking the election of directors for another year (or three years in the case of those with a staggered board).  

Most shareholders are asked to vote on a single, unopposed slate of directors.  Although all shareholders have the legal authority to nominate directors, the candidates in the proxy statement have been nominated by the board of directors.  Shareholders do not typically run competing slates because of the costs associated with the proxy process.  Moreover, while the costs of the solicitation of management's nominees are borne by the company, the costs of the solicitation for shareholder nominees must be borne by the shareholder.

Running unopposed, the directors nominated by the board will always be elected.  The one slight variation is that a number of public companies have in place majority vote requirements.  If directors do not receive a majority of the votes cast, they must submit letters of resignation.  It is then up to the remaining directors to decide whether to accept the resignation.  The dynamics of board behavior suggest that in many cases the letters will not be accepted.

This suggests that, structurally, directors are not at risk of losing their position on the board through shareholder opposition.  Thus, directors approving practices opposed by shareholders (excessive compensation, for example), are not likely to lose their positions. 

On the other hand, a director will lose his or her position if not renominated by the board.  Conventional wisdom has it that directors who have an antagonistic relationship with the CEO are at risk for not being renominated.  The antagonistic relationship can presumably arise from personality differences.  They can also presumably arise from genuine differences in policy, including those involving executive compensation. 

The WSJ recently described efforts by Bank of America to alter the composition of the Board of Directors.   The Board had apparently been shaped by pressure from governent regulators during the post-financial crisis period. With the pressure off, BofA had greater flexibility to shape the board in a manner deemed best for its business.  

According to the article, BofA had replaced "financial experts" on the Board with executives from "heavily regulated, highly competitive industries often plagued by thin profit margins."  As the article observed:

• In its search for new directors, the bank is looking for people who can help find ways to increase profit margins. Bank of America's return on assets in 2012 was 0.19%, compared with 0.97% for all U.S. banks, according to Federal Deposit Insurance Corp. data.

The article also noted, however, that some of the departed directors were described as those who "didn't click with" the CEO or had "tended to ask the 'tougher questions'" of the CEO.  See Id.  ("'People with knowledge and a deep understanding of the industry, they ask tougher questions than the people who don't know the industry and haven't been around for a while,' said the person.").

There is nothing in the article suggesting that the willingness to ask "tougher questions" was the reason for the removal of any director.  Nonetheless, as noted above, such behavior poses some potential risk for directors wishing to stay on the board. 

http://online.wsj.com/article/SB10001424127887324373204578376531266911080.html?mod=WSJ_hp_LEFTWhatsNewsCollection&cb=logged0.7570029061360173

Representative Markey Urges SEC Chairman Walter to use the Market Reform Act of 1990 to Fight High Frequency Trading

In a letter dated January 18, 2013, Representative Edward Markey (“Markey”) (D-Mass) encouraged the Securities and Exchange Commission (“SEC”) to curtail the use of high frequency trading (“HFT”) in equities markets.  HFT uses algorithms to buy and sell securities at incredibly fast speeds—up to one millionth (1/1,000,000) of a second—and it accounts for 70 percent of trading volume in the United States.  Markey noted that HFT use has exaggerated market volatility in recent years.

Markey described HFT as “a clear and present danger to the stability and safety of our markets” and advised the SEC to consider using the Market Reform Act of 1990 (the “Act”), which Markey himself coauthored, to combat such practices.  The Act provides the SEC with authority “to prohibit or limit practices which result in extraordinary levels of volatility.”

Initially used to curb automatic trading program abuses following the October 1987 Crash, the Act gives the SEC power to limit practices that affect market volatility and price level manipulation.  However, Markey pointed out that the Act may also be applied to HFT so long as the SEC finds that a period of “extraordinary market volatility” exists and that HFT is “reasonably certain to engender such levels of volatility.”  Moreover, Markey stated that such findings would be easy to make.

Markey requested that Chairman Walter respond to his letter by February 7, 2013.

The primary materials for this letter may be found on the DU Corporate Governance website.

Exchange Act Release No. 68640: SEC Approves Changes to NASDAQ Compensation Committee Rules

On September 25, 2012, NASDAQ filed a proposed rule change with the Securities and Exchange Commission (“SEC”) to amend Rules 5605 and 5615 to comply with the recently adopted Rule 10C-1.  17 CFR 240.10C-1.  Rule 10C-1  prohibits a national exchange from listing any equity security of an issuer (with certain exceptions), unless the issuer complies with the rules regarding compensation committees and compensation advisors.  On January 11, 2013, the SEC approved NASDAQ’s proposed changes, as amended.  See Notice of Filing of Amendments Nos. 1 and 2, and Order Granting Accelerated Approval of Proposed Rule Change, Exchange Act Release No. 68640 (Jan. 11, 2013).

Under the amended listing standards, Rule 5605(d) requires each listing company to have a compensation committee made up of independent directors and a committee charter detailing the committee’s responsibilities.  Issuers must comply with the new provisions by the earlier of either their first annual meeting after January 15, 2014, or October 31, 2014.  Issuers must also certify to NASDAQ that they have complied with Rule 5605(d) within 30 days of whichever deadline is applicable to that issuer.

Previously, NASDAQ had allowed listed companies the choice of having a formal compensation committee comprised of Independent Directors, or allowing the independent directors of the board to decide compensation decisions.  Under the amended rule, companies no longer have the choice.  A compensation committee with at least two members who are independent directors is now required.   

 Rule 5605(d), as amended, expands the factors that boards must consider in determining director independence.  Each member of a compensation committee is now prohibited from accepting, directly or indirectly, any consulting, advisory or other compensatory fee from the listed company or any of its subsidiaries.  In addition, the board must “consider whether the director is affiliated with the company, a subsidiary of the company, or an affiliate of a subsidiary of the company to determine whether such affiliation would impair the director’s judgment as a member of the compensation committee.”

NASDAQ’s rule also includes an exception that allows a director who does not meet the definition of an independent director to serve on a compensation committee in “limited and exceptional” circumstances.  A director, however, cannot be an executive officer (or their family member) and cannot serve more than two years.   Any company using this exception must disclose on its website or in its proxy statement the nature of the relationship and the reasons for determining that the membership is required in order to serve the best interests of the company and its shareholders.  Additionally, the Rule provides a cure period if a company fails to comply with the Independent Director standards. 

Under amended Rule 5605(d), a compensation committee is required to have a written charter that must be reviewed on an annual basis.  The charter must contain the following: (1) the specific scope of the “committee’s responsibilities and how it carries out those responsibilities, including structure, processes, and membership requirements”; (2) a statement specifying the “committee’s responsibility for determining or recommending to the board for determination, the compensation of the CEO and all other executive[s]”; and (3) a statement that the “CEO may not be present during voting or deliberations on his or her compensation.”

NASDAQ also amended Rule 5605(d)(3).  The provision grants the compensation committee the sole authority to obtain the advice of a compensation consultant, legal counsel, or other adviser other than in-house legal counsel.  Such advisers may only be selected after the committee has taken into consideration the six independence factors.[1]  Although consideration of the factors is mandatory, the Rule does not actually require that the committee select an independent compensation advisor.  Companies are mandated to comply with the new provisions of 5605(d)(3) by July 1, 2013.

In addition, NASDAQ retained some existing exemptions.   This included “exemptions for asset-backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies registered under the Investment Company Act of 1940 (“registered management investment companies”), and controlled companies.”  The SEC approved this continued exemption. 

Finally, NASDAQ addressed foreign private issuers.  A foreign issuer continues to be allowed to follow its home country practice in lieu of many of NASDAQ’s corporate governance listing standards, including the compensation-related listing rules.  Issuers adhering to their home country’s practices  must disclose in their annual report filed with the SEC each NASDAQ requirement not followed and describe the alternative home country practice.  In addition, foreign issuers must disclose the reasons why they do not have an independent compensation committee as required by NASDAQ’s standards in their annual report. The SEC also approved a phase-in schedule for initial public offerings, companies that lose their exemptions, companies transferring from other markets, and those deemed smaller reporting companies.

The SEC stated that it believes the rules being adopted “should benefit investors by helping listed companies make informed decisions regarding the amount and form of executive compensation.”  It also found these changes to be consistent with the requirements of Rule 10C-1. 

Therefore, the SEC issued an order granting the accelerated approval of the proposed changes.

The primary materials for this case may be found on the DU Corporate Governance Website. 

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[1] The six factors the committee must take into account when selecting an advisor are the following: (1) the other services the advisor provides to the company, (2) the amount of fees the advisor receives from the company (as a percentage of the total revenue of the person employing the advisor), (3) the policies and procedures of the person that employs the advisor that are designed to prevent conflicts of interest,(4) any business or personal relationship of the advisor with a member of the compensation committee, (5) any company stock owned by the advisor, and (6) any business or personal relationship of the advisor or the person employing the advisor with an executive officer of the company.

SEC Files Its Initial Brief in Conflict Minerals Case

On March 1, 2013 the SEC filed its Initial Brief (available here) in the pending case challenging the Commission’s final conflict minerals rules.  (more detail about the case and the rule available in an earlier blog).

 In its brief the SEC responded to petitioners’ claims that enactment of the final rule was arbitrary and capricious because “the Commission has a unique obligation to consider the effect of the new rule upon 'efficiency, competition, and capital formation' ... and its failure to 'apprise itself –and hence the public and the Congress - of the economic consequences of a proposed regulation makes promulgation of the rule arbitrary and capricious and not in accordance with law.”

In response, the SEC stated that petitioners make a fatal error when they

• “assume the Commission is authorized to second-guess and recalibrate policy judgments Congress made when it ordered the Commission to promulgate that rule. This novel and erroneous view animates their argument that the Commission was precluded from implementing Congress’s directive unless it independently confirmed Congress’s judgment that the statutorily mandated disclosure regime would produce the humanitarian benefits Congress intended. It also underlies their arguments that the Commission was required to use its interpretive and exemptive authority to adopt proposed alternatives that would reduce the statute’s costs even where the Commission concluded that doing so would undermine congressional intent. But neither the Administrative Procedure Act (“APA”) nor the Commission’s obligation to determine as best it can the economic implications of its rules gives the agency license to frustrate Congress’s purposes based on its own re-weighing of the benefits and burdens of Congress’s choices. “

In the view of the SEC, because Congress determined that the required disclosures will further the goals of the statute, the Commission’s job was to implement disclosure regulations, not to second-guessing Congress’s judgment by weighing whether the disclosures would promote the statute’s humanitarian goals.

The basic gist of the SEC’s argument is, not surprisingly, that it attempted to reduce the rule’s burdens while remaining faithful to Congress’s intent.   The brief states that

• “Recognizing that the rule would “impose significant compliance costs on companies who use or supply conflict minerals,” the Commission incorporated changes from the proposal to “reduce the burden of compliance in areas in which [it had] discretion while remaining faithful to the language and intent of” Section 1502. Adopting Release, 77 FR 56,279/1-2. The Commission thus rejected several more costly alternative proposals and accepted numerous recommendations to reduce issuers’ compliance burdens. In some circumstances, however, such as those petitioners challenge, the Commission determined that recommended alternatives would undermine the scheme Congress envisioned.”

Further, the Commission:

• “considered the costs and benefits of the rule as well as its effects on efficiency, competition, and capital formation…In conducting that analysis, the Commission thoroughly considered the economic consequences of the rule. It appropriately analyzed the empirical data commentators provided to produce a detailed estimate of the costs of the final rule. The Commission also provided a comprehensive qualitative analysis of its major discretionary choices. And the Commission’s choices themselves were reasonable in light of the correct reading of the statutory language, congressional intent, and the evidence in the extensive administrative record. “

Oral arguments in the case are scheduled for May 15, 2013.  The decision will be an important signal of the DC Circuit Court’s willingness to use the arbitrary and capricious standard to overturn SEC rulemaking.  The use of that standard is becoming more and more common given the success recent petitioners have had in cases involving proxy access as well as others.  A victory for petitioners here will only encourage more such actions in the future.

On another level, the conflict minerals case is important as an example of the overburdening of the SEC disclosure process, discussed in more detail in Conflict Minerals and SEC Disclosure Regulation .  Even if the process the SEC engaged in when adopting the final conflict minerals rules was not arbitrary and capricious it certainly was outside the normal bailiwick of SEC concerns.  While no one argues that stopping the atrocities in the DRC is not an admirable goal, it is far removed from the mission of SEC which it states is to “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”  Commissioner Shapiro acknowledged as much when discussing the implementation process.  There are more appropriate venues and mechanisms to address the real concerns about violence in the DRC that are the purported motivation for the conflict minerals rules.  Congress should not rely on the SEC to take action that Congress has shied away from. 

Banyan Inv. Co. v. Evans: Court Allows Member of an LLC to Bring Direct Claims Against Other Members

In Banyan Inv. Co. v. Evans, 292 P.3d 698 (Utah Ct. App. 2012), the Utah Court of Appeals reversed the trial court’s dismissal of the plaintiff’s claims.  Banyan Investment Company, LLC (“Plaintiff”), one of six members of Aspen Press Company, LLC (“Aspen”), brought direct claims against the other five members (collectively, “Defendants”).  

Plaintiff alleged Defendants, in managing Aspen, engaged in self-serving conduct to the detriment of Plaintiff.  Defendants moved for dismissal on the grounds that the claims were derivative in nature and could not be brought directly.  The trial court granted the motion.  Plaintiff amended the complaint to include derivative claims but also appealed the dismissal. 

The court first analyzed whether Plaintiff waived the right to appeal the dismissal by filing an amended complaint.  An amended complaint supersedes the original and acts as a waiver of the right to appeal the original dismissed complaint.  However, an exception occurs when a court dismisses the original complaint on the merits, rather than for a technical defect.  Since the trial court dismissed the direct claims on the merits, Plaintiff did not waive the right to appeal. 

The court then looked at the substance of the original complaint.  Generally, shareholders must file claims that involve injury to the entity derivatively.  The closely-held corporation exception, however, allows “minority shareholder[s] in a closely held corporation to proceed directly against corporate officers” instead of bringing derivative claims.  The closely-held corporation exception applies “where a minority shareholder suffers uniquely as a result of majority shareholders engaging in the type of wrongdoing that would ordinarily give rise only to a derivative claim.”  In these circumstances, minority shareholders may bring a “classic” derivative claim directly so long as the claim does not “(i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons.” 

Defendants argued the exception was inapplicable to LLCs.  The exception was designed to allow actions involving actions that harmed minority shareholders but benefited majority shareholders.  The court, however, determined an LLC management structure was similar to that of a closely held corporation and that the exception extended to LLCs. 

Defendants also asserted that even if the exception did apply, Plaintiff failed to allege an injury distinct from that suffered by Aspen.  A distinct injury from the corporation was not a requirement of the closely held corporation exception.  The court reasoned that if a distinct injury were required, the exception would be unnecessary since a separate injury already gives rise to a direct cause of action.  Instead, Plaintiff must show an injury that is “distinct from that suffered by other shareholders.”  Since Plaintiff claimed a unique injury from Defendants, its claims were valid. 

Although it was within the discretion of the trial court to insist on a derivative action, the trial court had only dismissed the complaint based on its inaccurate application of the closely held corporation exception.  Therefore, the Utah Court of Appeals reversed the dismissal. 

The primary materials for this case may be found on the DU Corporate Governance website.

Freeman Investments L.P. v. Pacific Life Insurance Co.: SLUSA Precludes Class Actions for Breach of a Variable Universal Life Insurance Contract

In Freeman Inv. L.P. v. Pacific Life Ins. Co., No. 09-55513, 2013 WL 11884 (9th Cir. Jan. 2, 2013), the Ninth Circuit Court of Appeals affirmed in part, reversed in part, and remanded the district court's grant of Pacific Life Insurance Co.'s ("Pacific") motion to dismiss. The Ninth Circuit reversed the dismissal of Freeman Investments, L.P.'s ("Freeman") class action claim alleging breach of contract and the duty of good faith and fair dealing. Freeman's claims against Pacific for breach of its variable universal life insurance contract pursuant to California unfair competition laws, however, did not survive the Securities Litigation Uniform  Standards Act of 1998 ("SLUSA"), and the court affirmed the dismissal of this claim.

Variable universal life insurance contracts differ from term life insurance because they exist for the duration of the policyholder's life, and they permit policyholders to share in the gains or losses resulting from invested premiums by allowing them to borrow against or cash out the accumulated value of the policy. The life insurance contracts place the risk of the investments on the policyholder. For this reason, some circuits have held that variable universal policies qualify as securities.

Pacific allocated a portion of the premiums into a separate account and then invested the amount in accordance with the choices made by policyholders. Each month Pacific charged a "cost of insurance" fee, and deducted the fee from Freeman's account.  Freeman asserted in his complaint that "cost of insurance" was excessive.  Specifically, he alleged that "cost of insurance" was an industry term of art and that the amount of the deduction should have been computed in conformity with these industry standards.  As a result, he brought an action for breach of contract, breach of the duty of good faith and fair dealing and unfair competition.

Pacific sought dismissal under SLUSA. SLUSA precludes state law class actions alleging that the defendant made a misrepresentation in connection with the sale of securities.

SLUSA applies irrespective of the type of claim.

The court concluded that Freeman's claim for breach of contract involved a dispute about the interpretation of a term and was not dependent upon a misrepresentation. See Id. (“To succeed on this claim, plaintiffs need not show that Pacific misrepresented the cost of insurance or omitted critical details. They need only persuade the court that theirs is the better reading of the contract term.”).

Freeman's claim of unfair competition, however, was based upon misrepresentation. See Id. (“But California business & Professions Code § 17200, on which plaintiffs base a separate claim, defines unfair competition as ‘any unlawful, unfair or fraudulent business act or practice.’").

Moreover, the court found that the claim did meet the "in connection with" test. The court explained that the mere presence of a security was not sufficient, that the misrepresentation at issue had to relate to the nature of the security—something more than a tangential relationship. Further, the court pointed out that the allegation of an inflated cost of insurance directly reduced the amount invested in securities. Because of the insurance and security hybrid nature of universal life insurance, a claim could survive SLUSA if it only discussed the insurance aspects of the policy; however, here the court explained that the cost of insurance fee far exceeded a tangential relationship by directly depleting the value of the security investment.

The court concluded that Freeman's breach of variable universal life insurance contract claim was precluded by SLUSA.    

The primary materials for this case may be found on the DU Corporate Governance website.

Couture on Opinions Actionable as Securities Fraud

Wendy Gerwick Couture recently published an article in the Louisiana Law Review entitled, “Opinions Actionable as Securities Fraud.”  A draft of the paper is available on SSRN (here) with the following abstract:

This Article proposes a new analytical framework to apply to statements of opinion in securities fraud cases. Although statements of opinion form the basis of some of the most cutting-edge securities fraud claims -- such as those asserted against securities analysts and credit rating agencies -- statements of opinion do not fit squarely within the elements of securities fraud. In particular, three issues arise: (1) When is a statement of opinion "false" so as to qualify as a misrepresentation? (2) When is a statement of opinion "material"? (3) And, for that matter, what is the distinction between a statement of fact and a statement of opinion? Courts confronting these issues apply various analytically unsound and inconsistent tests. In response, this Article, drawing on the policy rationales underlying securities fraud claims, case law and scholarly commentary addressing how to apply the elements of securities fraud to statements of opinion, and comparable analyses in the contexts of common law fraud and defamation, proposes a novel approach. First, this Article argues that statements of opinion are only false if both objectively unreasonable and subjectively disbelieved. Second, this Article proposes the following new "evaluation/deduction test" to differentiate statements of opinion from statements of fact: Does the statement express the speaker's evaluation or deduction of facts? Finally, this Article proposes the following new "reasonable implication test" to distinguish opinions that are immaterial as a matter of law from those that are potentially material: Does the opinion reasonably imply an allegedly false, material fact?

As a follower of the Bainbridge school of shameless self-promotion (Why blog, if not to at least occasionally promote oneself?), I would be remiss if I did not highlight the article’s reference to my own work (available here):

[C]ourts are correct that no reasonable investor would interpret the opinion “we currently view our shares as undervalued” as a representation that the shares' fundamental value is higher than the market price, but a reasonable investor could interpret it as a representation that the company is not insolvent, rendering its shares worthless. Dismissal of opinions like this one without an inquiry into what component of the opinion is allegedly false fails to recognize this nuance.

Indeed, the results of a recent materiality survey performed by Professor Padfield are consistent with this analytical flaw. The survey presented five short factual scenarios, drawn from actual cases in which alleged misrepresentations were dismissed as immaterial, and asked participants if they would “consider the additional information important in deciding whether to buy [the company's] stock.” For example, the survey presented some background information about the demand for Telco's product, the T-6500. Then, the survey asked the following question:

Assume you are now considering buying Telco stock and you receive the following additional information: Later, in response to a question, Telco's CEO states, “On the 6500, demand for that product is exceeding our expectations.” Would you consider the additional information important in deciding whether to buy Telco stock? Yes [or] no.

Sixty-two percent of the survey's respondents answered “yes.” Professor Padfield interpreted the survey results as suggesting “that judges are too quick to grant dismissals in securities cases on the basis of puffery.”

This author agrees with Professor Padfield's conclusion but argues further that the survey highlights the importance of incorporating alleged falsity into the materiality analysis. Notably missing from the survey's factual scenarios were allegations about why the statements were false. For example, on one hand, a reasonable investor might very well consider the Telco CEO's statement to be material because it implies that the 6500 product is still in production. On the other hand, no reasonable investor would consider the CEO's statement to constitute an implied representation about a specific level of demand for the product. Asking survey participants to assess the materiality of the statement in a vacuum, effectively asking them to speculate for themselves about why a statement might be misleading, invariably leads to inconsistent results, as it did in this survey. The same lesson applies to courts.

I don’t believe the survey led to inconsistent results.  True, there are additional facts that could have been provided that would have led to respondents giving different responses, but since the goal of the survey was to test investor responses to statements as they were actually analyzed by the courts, adding additional facts would not have made the results more consistent, it would simply have defeated the purpose of the survey.  Having said that, to the extent Couture’s point is that courts would do a better job with their materiality determinations if they were more specific about the alternative interpretations reasonable investors could give to challenged statements—I think there may be something to that (and to the extent surveys become a part of that analysis, they should reflect that change).  Certainly, it would seem to make the process more consistent with the Supreme Court’s admonition in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 450, that:

[T]he underlying objective facts, which will often be free from dispute, are merely the starting point for the ultimate determination of materiality. The determination requires delicate assessments of the inferences a “reasonable shareholder” would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact.  Only if the established omissions are “so obviously important to an investor, that reasonable minds cannot differ on the question of materiality” is the ultimate issue of materiality appropriately resolved “as a matter of law” by summary judgment.

Sarafin v. BioMimetic: Statements without Scienter are not Fraudulent

In Sarafin v. BioMimetic Therapeutics, Inc., the United States District Court for the Middle District of Tennessee found that Charles M. Sarafin and other holders of BioMimetic Therapeutics, Inc. (“BMTI”) stock (collectively, the “Plaintiffs”), failed to produce sufficient evidence that BMTI acted with scienter in connection with an action for securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  No. 3:11-0653, 2013 WL 139521 (M.D. Tenn. Jan. 10, 2013).  The court, therefore, granted BMTI’s Motion to Dismiss.

According to the complaint, BMTI wanted to enter the United States healthcare market through its Augment Bone Grafting (“Augment”) device.  Augment is a device and biological drug that would stimulate the development of osteoblasts, which are the cells that form bones.  Between October 2009 and August 2010, BMTI stated that Augment would likely be successful in the Food and Drug Administration’s (the “FDA”) Premarket Approval process.  The FDA, however, expressed concerns about Augment’s effectiveness in a Deficiency Letter to BMTI on September 3, 2010.  The FDA also expressed concerns in briefing documents published on May 10, 2011, in advance of the public meeting before the panel of experts. In January 2012, BMTI announced that the FDA would not approve Augment without additional information.

Plaintiffs filed a lawsuit alleging fraud and that BMTI violated Section 10(b) and Rule 10b-5 by misstating or omitting material facts with scienter.  Specifically, Plaintiffs contended that BMTI knowingly made fraudulent statements about the FDA’s approval of Augment.  BMTI filed a Motion to Dismiss, alleging that Plaintiffs failed to establish fraud and scienter.

To assert a successful claim under Section 10(b) and Rule 10b-5, a plaintiff must allege, “in connection with the purchase or sale of securities, the misstatement or omission of a material fact, made with scienter, upon which the plaintiff justifiably relied and which proximately caused the plaintiff’s injury.”  Scienter requires “a knowing and deliberate intent to manipulate, deceive, or defraud, and recklessness.”  A misstatement “or an omission is material only if there is a substantial likelihood that a reasonable investor would have viewed the misrepresentation or omission as having significantly altered the total mix of information made available[; however,] obviously unimportant, vague, or puffing statements, expressions of corporate optimism, and obvious hyperbole are not actionable” (internal quotation marks omitted).  “The ‘total mix’ of information includes information in the public domain and facts known or reasonably available to investors.” 

The court ruled that Plaintiffs’ allegations did not sufficiently show that BMTI acted with scienter.  The court concluded that, while BMTI “perhaps, could have characterized things differently,” the challenged disclosures did “not suggest a knowing and deliberate intent to deceive or defraud, let alone highly unreasonable conduct on the part of BMTI.”  

As for the contention that BMTI “concealed numerous other serious deficiencies in their conduct of the clinical trials,” the claim did not “raise a strong inference of fraudulent intent as required by the [Private Securities Litigation Reform Act of 1995].”  As the court reasoned:

The notion that BMTI would recklessly forego necessary tests and studies or hide adverse events makes little sense, even disregarding [BMTI’s] assertion that they poured their own money into the company.  Plaintiffs’ own allegation is that Augment is BMTI’s flagship product and necessary to the [company’s] success, begging the question why it would sabotage all of the company's efforts to that point.

The court also pointed out that there had not been allegations that “individual defendants received any financial benefit as a result of BMTI’s alleged deception.”  

The primary materials for this case may be found on the DU Corporate Governance website.

Monk v. Johnson & Johnson: PSLRA Requires Stay of Discovery Pending a Second Motion to Dismiss

In Monk v. Johnson & Johnson, No. 10-4841 (FLW), 2013 WL 436514 (D.N.J. Feb. 5, 2013), the United States District Court for the District of New Jersey granted Defendant Johnson & Johnson's ("J & J") application to stay all discovery pending the outcome of J & J's Motion to Dismiss Plaintiff Monk's Second Amended Complaint.

 Monk brought a class action against Johnson, alleging that some former and some current officers and directors of J & J, and a J & J subsidiary, misrepresented and omitted material information to shareholders concerning quality control failures at the subsidiary drug manufacturing plants.

 Monk filed an amended complaint on March 11, 2011. J & J filed a Motion to Dismiss that was partially successful. Monk's Motion for Reconsideration was denied, but the court granted leave to file a Second Amended Complaint. Monk filed the second amended complaint on September 7, 2012. J & J moved to dismiss most of the claims in the Second Amended Complaint—including newly added claims and two of the three previous claims.

While J & J's Motion to Dismiss was pending, J & J sought a stay of discovery under the Private Securities Litigation Reform Act ("PSLRA"). The PSLRA discovery stay provision states: "In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motions to dismiss unless the Court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." J & J asserted that the PSLRA required a stay of all discovery, and it did not distinguish between first and second motions to dismiss or between motions to dismiss some or all of the complaint.

 J & J argued that both the claims from both complaints were closely related and that a stay would help to avoid extraneous discovery. Monk argued that a stay of discovery in connection with the first set of claims would generate delay and result in undue prejudice.

 The court disagreed with Monk. The court stated that because delay was inherent in every stay of discovery required by  PSLRA, mere delay did not create undue prejudice. The court agreed with J & J that Monk's previous claims and his new claims related to the same essential events, and that bifurcating the discovery would create confusion.

 Moreover, the court noted that PSLRA's expansive language suggested that discovery of all motions to dismiss must be stayed, even in light of an earlier denied motion to dismiss. The court justified its actions by clarifying that it had inherent authority to impose a stay of discovery to encourage efficiency.

The court granted J & J's application to stay all discovery pending the outcome of J & J's Motion to Dismiss.

 The primary materials for this case may be found on the DU Corporate Governance website.

Cement Masons & Plasterers Joint Pension Trust v. Equinix, Inc.: A Sudden Decrease in Stock Price Alone Does Not Equal Securities Violations

In Cement Masons & Plasterers Joint Pension Trust v. Equinix, Inc., No. 11–01016 SC, 2012 WL 6044787 (N.D. Cal. Dec. 5, 2012), the U.S. District Court for the Northern District of California dismissed the plaintiffs’ claims, for a second time, for failure to plead actionable conduct pursuant to Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”).

Plaintiffs, Cement Masons & Plasterers Joint Pension Trust and the International Brotherhood of Electrical Workers Local 697 Pension Fund (collectively, the “Plaintiffs”), brought an action against Equinix, Inc. (“Equinix”), and Equinix’s CEO, Stephen Smith, and CFO, Keith Taylor (collectively, the “Defendants”), for violations of Sections 10(b) and 20(a) of the Exchange Act and Securities and Exchange Commission (“SEC”) Rule 10b–5. Plaintiffs alleged that the Defendants artificially inflated Equinix’s stock price by issuing false and misleading statements concerning: (i) financial forecasts, (ii) integration efforts between Equinix and recently acquired Switch & Data Facilities Company, Inc. (“Switch & Data”), and (iii) pricing strategy. The court dismissed the claim associated with financial forecasts in a prior motion to dismiss.

Section 10(b) makes it unlawful to “use or employ, in connection with the purchase or sale of any security registered on a national security exchange . . . any manipulative or deceptive device or contrivances in contravention of such rules and regulations as the [SEC] may prescribe.” Rule 10b–5 prohibits persons from “engag[ing] in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.” Courts require five elements to establish Rule 10b–5 violations: “(1) a material misrepresentation or omission of fact, (2) scienter, (3) a connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss.” Plaintiffs must also satisfy Fed. R. Civ. P. Rule 9(b), requiring a heightened standard of pleading for claims alleging fraud or mistake.  

Plaintiffs challenged statements made by the Defendants in mid-2010 where Defendants represented that integration efforts with Switch and Data were ahead of schedule and that their sales organizations were completely integrated. Subsequently, Equinix disclosed that it had not met fourth quarter projections and that “it still [had] work to do to realign the combined sales organization.”

Plaintiffs also alleged that Defendants stated in July that Equinix would stay true to its pricing parameters and would not chase business in light of the competitive market. In its October statements, however, the Defendants admitted to Equinix having to discount prices to extend long-term contracts with strategic customers. Moreover, a confidential witness claimed that Equinix “regularly” approved discounts between ten and thirty percent during the period the Defendants averred the pricing was stable.

The court found that the statements concerning integration were not “forward looking” and therefore not covered by the safe harbor projections in the PSLRA.  The court agreed, however, that the Defendant’s October statements failed to satisfy the scienter and falsity elements. The alleged misstatements “merely show that Equinix was unable to achieve the revenue synergies that Equinix sales teams had been focused on in July” and that “the integration did not proceed as smoothly as they hoped.”

In addressing the statements concerning pricing strategy, the court explained that the Defendants maintained a consistent position on pricing through the period at issue. The court further noted that there was no indication that the widespread discounting was disclosed to the market. Emphasizing the absence of an economic loss, the court held that “[b]ecause the widespread discounting described by [the confidential witness] was never revealed to the market, it could not have caused Equinix’s stock price to drop . . . or otherwise caused Plaintiffs’ alleged loss.”

Finally, the court explained that absent an underlying violation of the Exchange Act, there could be no Section 20(a) liability for control persons. Thus, the court granted the Defendants’ motion to dismiss with leave to the Plaintiffs to amend for a second time.             

The primary materials for this case may be found on the DU Corporate Governance website.

SEC Compliance and Disclosure Interpretations Regarding the Iran Threat Reduction and Syria Human Rights Act of 2012

Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 amended the Securities Exchange Act of 1934 (Exchange Act) to require disclosure of certain activities relating to Iran.    

Disclosure is triggered when companies knowingly engage in the activities specified in the statute.  These include, assistance in the development of petroleum and refined petroleum production resources in Iran; assistance in the development, research, or financing of any stage of production of weapons of mass destruction; financing that benefits Iran’s Revolutionary Guard Corps; and participation any transaction or dealing relating to persons who commit, threaten to commit, or support terrorism. Additionally, unless a United States federal department or agency authorized the specific activities, any transaction or dealing with a person or entity within the definition of the Government of Iran triggers the mandatory disclosure requirements.

In general, any issuer or its affiliate must disclose any of the activities enumerated in section 13(r)(1) in its quarterly or annual reports due after February 6, 2013, regardless of the actual date of filing. An “affiliate,” as defined by Rule 12b-2 of the Exchange Act, is “any person that directly, or indirectly, through one or more intermediaries, controls, or is controlled by, or is under common control with” the issuer. Any enumerated activity engaged in during the time-period covered by the reports due after February 6, 2013 triggers mandatory disclosure requirements, regardless of whether the activity occurred before the promulgation of the amendment.

Under Section 13(r)(2) and (3), the issuer or its affiliate must include a detailed description of each activity in its annual or quarterly report, including the nature and extent of the activity, the gross revenues and net profits attributable to the activity, and whether the issuer or the affiliate intends to continue the activity. The issuer or its affiliate must also provide a notice to the SEC identifying itself as a party that made disclosures of one or more enumerated activity within its report.  

The SEC will make the report public and also transmit it to the President of the United States , the Committee on Foreign Affairs and Financial Services of the House of Representatives, and the Committee on Banking, Housing, and Urban Affairs of the Senate under Section 13(r)(4).     

Section 13(r)(5) requires the President, on reception of a report that includes a disclosure of an enumerated activity (excluding activities authorized by a federal department or agency), to initiate an investigation into the possible imposable sanctions on Iran pursuant to various applicable pieces of legislation. The President will also make a determination with respect to whether or not imposable sanctions are necessary for the issuer or its affiliate.

The Compliance and Disclosure Interpretations may be found on the SEC website.

Freedman v. Adams: The Business Judgment Rule Wins Again

In Freedman v. Adams, 58 A.3d 414 (Del. January 14, 2013), the Supreme Court of Delaware affirmed the Court of Chancery’s decision that the plaintiff did not adequately state a claim for waste in her derivative suit against XTO Energy, Inc.’s (“XTO”) board of directors.

Susan Freedman (“Plaintiff”) was a stockholder of XTO, an oil and gas company that Exxon Mobile (“Exxon”) acquired in 2010. In 2008, Plaintiff filed a derivative action on behalf of XTO that accused the board of committing waste. Plaintiff alleged that the failure of XTO’s board to adopt a plan that could have made the company’s bonus payments tax deductible cost the company $40 million over a three-year period. Compensation paid to company executives greater than $1 million is only tax deductible if paid according to § 162(m) of the Internal Revenue Code. The XTO board, while allegedly aware of the potential benefits of §162(m), did not wish to be “constrained” by such a plan.

XTO’s board eventually approved a §162(m) plan, but never used it because Exxon acquired the company shortly afterwards. Plaintiff dismissed her initial complaint as moot but filed a motion seeking $1 million in attorneys’ fees. She asserted that her initial complaint “benefitted the company by causing XTO to adopt a Section 162(m) plan.” The Court of Chancery denied the motion.

Normally a claimant in a derivative suit must show, “with particularity, that [a] demand on the board of directors to redress the alleged wrong would have been futile”; however, a successful claim of waste not only denies the board the protection of the business judgment rule, but also negates the demand requirement. Plaintiff therefore only appealed the finding that the complaint did not state a claim for waste.

To state a claim for waste, a plaintiff must allege, with particularity, “that the board authorized action that no reasonable person would consider fair.” Plaintiff argued that “the board's failure to adopt a Section 162(m) plan... amounted to a gift in the form of tax payments that were not required” and that this omission was sufficient to establish a prima facie case of corporate waste. The court did not agree for two reasons. First, the complaint did not allege that any of the actual bonuses paid to XTO executives would have been tax deductible. Second, the board chose not to employ a Section 162(m) plan with full knowledge of the tax implications. The board “believed that a Section 162(m) plan would constrain the compensation committee in its determination of appropriate bonuses.”

 The court held that “[t]he decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment.” Even if the decision not to implement the Section 162(m) plan was a bad one, it was not bad enough to meet the “unconscionable or irrational” standard required to show corporate waste.

The primary materials for this case may be found on the DU Corporate Governance website.

The Benefits of the Falling Number of SEC Cases

he WSJ published a piece on the decline in the number of cases filed by the SEC.  The article suggests that this is a disaster for the Commission, one that will bring criticism from Congress and a headache for Mary Jo White.  There is, however, an entirely different way of looking at the issue.

First, an emphasis on numbers sends the wrong message.  The article indicated that the numbers were down from the SEC's "record breaking" numbers of the prior two years.  To the extent the SEC is judged based upon the number of actions (and the need to produce "record breaking" results every year), this will create incentives to bring actions designed to pad the numbers.  The result will be a swelling number of unimportant cases.  Dedicating multiple staff members to large investigations will be counter productive since they will likely bring fewer cases.  The result could easily be more cases but fewer that really matter.

Second, as the Madoff matter suggests, a pro-active SEC ought to have as its goal the exposure of fraud that is ongoing.  To do this, the SEC cannot simply wait until the fraud becomes public and investors have paid the price.  The SEC will need to continue to develop metrics that suggest the possibility of ongoing fraud and conduct immediate investigations.  One consequence of this approach, however, will be that more investigations end without a recommendation for an enforcement action.  In other words, fewer rather than more cases will be a better measure of success.

Mary Jo White may have to explain any decline to Congress and Congress may not always like the answer.  But the quality of the SEC's enforcement program is not something that can be or should be measured through excessive reliance on a single statistic:  The number of cases filed. 

Dari-Mattiacci, Gelderblom, Jonker & Perotti on “The Emergence of the Corporate Form”

Giuseppe Dari-Mattiacci, Oscar Gelderblom, Joost Jonker, and Enrico C. Perotti have posted “The Emergence of the Corporate Form” on SSRN.  Here is the abstract:

The Dutch East India Company (VOC) is generally viewed as the first modern corporation, yet its 1602 charter did not introduce all features of legal personality. A detailed historical analysis reveals how its statute proved inadequate to sustain the massive military investment needed to secure a strong trade position in Asia. In response, legal innovations were introduced in the subsequent twenty years. In 1612, state intervention overruled shareholder rights and created capital lock-in. The associated loss of control by shareholders was ultimately compensated by long-term profits, as the escalated commitment to Asia allowed the VOC to outperform its competitors. Once capital became permanent, VOC directors needed and gained the final corporate feature of general limited liability in 1623. We argue that this transition could be achieved while preserving private interests because the Dutch Republic’s limited form of government protected long term private capital, while autocratic colonial powers maintained a royal monopoly on colonial trade. The English East India Company adopted the much-admired Dutch model only half a century later, as the crown became subject to parliamentary control. By then the Dutch grip on South-East Asia had become entrenched, leading its competitors to focus elsewhere.

Gibbons v. Malone: Differences Between Securities in Same Company Essential when Avoiding the Application of Section 16(b) of the Securities Exchange Act

In Gibbons v. Malone, No. 11-3620-cv, 2013 WL 57844 (2d Cir. Jan. 7, 2013), the Second Circuit concluded that section 16(b) of the Securities Exchange Act of 1934 does not apply when an insider sells one class of stock and purchases another class from the same company. The court held that section 16(b) is inapplicable when the shares sold and bought are “separately traded, nonconvertible stocks with different voting rights.” 

In December of 2008, the director of Discovery Communications, Inc. (“Discovery”), John Malone (“Malone”), sold 953,506 shares of his “Series C” stock. That same month, Malone bought 632,700 shares of Discovery’s “Series A” stock. Plaintiff Michael Gibbons filed a shareholder’s suit alleging that Malone violated the short swing profits provision contained in Section 16(b) of the Exchange Act. 15 U.S.C. 78p(b).

The trial court dismissed Gibbons’ complaint. The trial court found that Section 16(b) did not apply to purchases and sales of different types of stock of the same company where the securities were “separately traded, nonconvertible, and [came] with different voting rights.”  

On appeal, the Second Circuit noted that section 16(b) endeavored to prevent corporate officers from unfairly profiting from the utilization of insider information by selling and buying, or buying and selling, a corporation’s security within a six-month period. The language of Section 16(b), however, applied to the purchase and sale, or sale and purchase, of “any equity security.”    The court viewed the language as applying the prohibition on short swing profits only to transactions in the same equity security. See Id. (“Congress's use of the singular term ‘any equity security’ supports an inference that transactions involving different equity securities cannot be paired under § 16(b).“).    

Accordingly, the court grappled with determining whether Discovery’s Series A stock and Series C stock were the “same security,” or at least so similar as to render them subject to Section 16(b). In making this determination, the court noted several distinctions between the Series A and Series C stock. First, they were not “economically equivalent” because the price of each fluctuated relative to the other. Second, Series A stock conferred voting rights to its holder while Series C did not. Finally, the two stocks were not convertible. The court noted that convertibility between the two stocks could be sufficient evidence that the stocks were similar enough to apply section 16(b). As a result of these distinctions, the two series were not the same security within the meaning of section 16(b).  

A Race to the Bottom post on the district court’s ruling of this case may be found here. The primary materials for this case may be found on the DU Corporate Governance website.

What to Expect This Proxy Season: Findings from Proxy Preview

As proxy season gears up, the new Proxy Preview report issued by As You Sow, an organization dedicated to “helping shareholders vote their values” contains a wealth of interesting information.  Shareholders advocacy is gaining force.  According to the Preview, investors this year will file approximately 400 shareholder proposals on social and environmental issues—a 50% increase  over a decade ago  While not all of these will result in votes, many of those that do not will encourage management-shareholder dialogue leading to the withdrawal of a proposal after the proponent reaches some agreement with management.

Not surprisingly, many of the resolutions filed center on corporate political spending. About 120 resolutions focus on political spending, about one-third of the total number of resolutions, and twice the number filed on the next most popular category this year: climate and energy.

"The trend on political spending has been around for several years now, and much of that has focused on political contributions to elections. But what started last year and kind of exploded this year is political lobbying disclosure," says Michael Passoff, co-author of the Proxy Preview and CEO of Proxy Impact, a progressive proxy voting service for socially responsible investors.

"In essence, what shareholders are asking for is disclosure on the political spending done on elections but also year-round," he says.

Resolutions concerning climate and energy, other environmental issues, and sustainable governance (including reporting) combined make up about equal parts of another 38% of the total. Human rights and decent work proposals make up a modest 8%, although some of these concerns are folded into the sustainability reporting requests. Proponents continue to promote board diversity and the need for board oversight of several different issues, accounting for another 6%, while employment diversity—mostly related to equal rights for lesbian, gay, bisexual, and transgender people—make up a further 6% with the remainder being a grab-bag.

Even though environmental topics are not the largest category of shareholder proposals, they remain important avenues for shareholder advocacy.  Investors filing proposals concerning environmental issues want companies to adopt policies for lowering emissions that are driving climate change and to report on how they are managing and mitigating related risks. In additional to proposals addressing climate change, environmental topics of concern to shareholders include, among others, the impact power sector companies (coal, shale gas, and nuclear) operations have on the environment, recycling and product responsibility, toxic materials, and water and forest management.

As discussed in an earlier posting, proposals addressing environmental concerns got a boost from the SEC this season when it refused to grant a no-action letter to PNC Financial Services which sought to block a proposal seeking the firm’s “assessment of the greenhouse gas emissions resulting from its lending portfolio and its exposure to climate change risk in its lending, investing, and financing activities.”  In an apparent SEC policy change, the Commission refused to concur with PNC Financial that it could exclude the proposal on the grounds that it dealt with ordinary business matters and instead found that it must be included as a proposal addressing an important social policy concern.  This ruling potentially opens a door for more resolutions seeking  climate change risk assessments throughout the financial sector.

Just who is bringing these proposals?  There are a wide range of groups responsible, ranging from big players including socially responsible investment firms Trillium Asset Management, Calvert Investments and Walden Asset Management, who together filed the most resolutions for 2013, followed by pension funds and faith-based groups. Individual proponents accounted for just 6 percent of the total filings this year.  Support for proposals also continues to increase.  The average support level has grown from 11.9% in 2003 to 18.5% in 2012. “Now you get a lot of votes that are in the 30 percent range, and some are majority votes," Passoff says. There is a trend of companies being more responsive to socially responsible investing, and mainstream investors are supporting them as well," he says.

The Preview includes far more information than can be summarized here, including an analysis of past proxy season results and outcomes.  What is clear from this year’s preview is that shareholder activism on social and environmental issues continues to grow and it will be harder and harder for companies to ignore.

Union de Empleados v. UBS Financial Services: Appellants Get a Second Chance

In Union de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan, Union de Empleados de Muelles de Puerto Rico AP Welfare Plan v. UBS Fin. Serv. Inc. of Puerto Rico, UBS Trust Co. of Puerto Rico, et.al, Union de Empleados de Muelles de Puerto Rico PRSSA Welfare Plan (“PRSSA”) and Union de Empleados de Muelles de Puerto Rico AP Welfare Plan (“AP”) (collectively, “Appellants”) alleged that UBS Financial Services Inc. of Puerto Rico (“UBS Financial”), UBS Trust Company (“UBS Trust”), and the Directors of the entities (collectively, “Defendants”) committed securities fraud by heavily investing in bonds.  No. 11 1605, 2013 WL 49818 (1st Cir. Jan. 4, 2013).  The district court dismissed the case; however, the appellate court vacated the dismissal and remanded the case for further proceedings.

The Appellants are Puerto Rico pension plans that invested in closed-end investment funds.  According to the complaint, AP owned shares in four such funds, while PRSSA owned shares in three of four of the same funds.   The board of each fund was identical.  Similarly, each had the same investment advisor, UBS Trust.  Acting in its role as investment advisor, UBS Trust purchased $757 million worth of bonds issued and underwritten by UBS Financial, an affiliate, and then sold those bonds to the funds.  Appellants alleged that the funds were so heavily invested in these bonds that when the value of the bonds dropped, the funds suffered serious financial losses.

Appellants filed a derivative action.  “A shareholder derivative action permits a shareholder of a corporation to bring suit to enforce rights the corporation is unable or unwilling to enforce on its own behalf.”  The trial court dismissed the action, finding that plaintiffs had not sufficiently pled demand futility.  The trial court declined the request to file an amended complaint designed to cure the pleading deficiencies. 

The court of appeals determined that the law of the state of incorporation governed the standard for demand futility.  Since, the funds were incorporated in Puerto Rico, the court looked to the law of that jurisdiction.  Because Puerto Rico had not set out standards for demand futility, the court opted to apply the law of Delaware.  Id.  (“we look to Delaware corporate law, on which Puerto Rico corporate law is modeled.”).  Under Rales v. Blasband, plaintiffs were required to allege facts that created “a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” 634 A.2d 927 (Del. 1993).  Demand, therefore, would be excused only if the majority of the board is interested or lacks independence.

An identical eleven-person board governed each of the four funds.  For the Appellants to prove demand futility, they had to create a reasonable doubt that six of the directors were not disinterested or independent.  The court held that the Appellants alleged sufficient facts to meet this burden. 

First, the complaint pointed to relationships between the directors and the Defendants that could preclude a finding that they were disinterested and impartial.  Directors Ubinas, Highley, and Ferrer were not only on the board for each of the four funds, but they all served in various executive positions with either, or both, UBS Trust and UBS Financial.  Director Roussin was a director of each of the four funds and a full-time employee of UBS Financial.  The court found that these divided loyalties raised reasonable doubt about the ability of these directors to act in a disinterested fashion in evaluating Appellants’ demand.

Lastly, the court looked at Directors Belaval and Leon, who shared nearly identical circumstances.  Both directors were executives of Triple S.  Triple S had a lucrative relationship with both UBS Trust and UBS Financial.  Because of the prior dealings these directors had, on behalf of Triple S, with both institutional Defendants and the possibility that they will need the business assistance of the UBS Defendants in the future, a reasonable doubt was created about their independence. 

Secondly, the trial court “misconstrued plaintiffs’ burden of demonstrating that the benefits . . . that the individual directors received” as part of their relationship with UBS Trust or UBS Financial were of “subjective material significance.” 

The court held that the Appellants’ derivative claim should not have been dismissed.  The dismissal was vacated and the case remanded for further proceedings.

The primary materials for this case may be found on the DU Corporate Governance website.

SEC Grants Request for No-Action Relief under Electronic Fund Remittance Transfers for Broker-Dealers

In response to a request letter from the Financial Information Forum’s Regulation E Working Group (“Working Group”), the Securities and Exchange Commission (“SEC”) agreed not to recommend enforcement action against broker-dealers who provide remittance transfers in the same way as “insured institutions.” Therefore, broker-dealers must follow Section 1005.32(a) and Section 1005.32(c) of Regulation E.

Registered broker-dealers often provide electronic fund transfer services. Section 1073 of the Dodd-Frank Act increased regulation of remittance transfers from customers in the United States to foreign institutions; now, broker-dealers must provide extensive disclosure on the terms of the transfers. These disclosure requirements include the exact transfer amount, transfer fees, and taxes. However, Regulation E has an exception for certain “insured depository institutions” and “insured credit unions” that allows for the disclosures to be “reasonably accurate estimates.” This exception expires on July 21, 2015.

The Working Group articulated in its letter a number of concerns pertaining to this new rule of disclosure as applied to broker-dealers. The primary concern was the difficulty that broker-dealers would face in accurately determining, recording, and disclosing all the charges that might occur en route to the destination of the remittance transfer. The Working Group explained that broker-dealers are not exclusively involved, and thus only aware, of the charges associated with the commencing broker-dealer. Beyond the step of initiating the transmitting route, the first broker-dealer is unaware of the resulting transfers to the ensuing financial institutions. Moreover, the information pertaining to the institution’s charges is not available because each transaction follows a unique path, and financial institutions beyond the jurisdiction of U.S. courts are not required or incentivized to share proprietary information.

The Working Group argued these logistical restraints in its letter submitted to the SEC and asked the SEC not to recommend enforcement action where broker-dealers provide estimates in the same manner as “insured institutions” in accordance with Section 1005.32(a) and Section 1005.32(c). Further, the Working Group presented arguments supporting the benefits of no enforcement. These included the following: (1) more widespread cohesion of remittance transfer providers to act within their compliance schedules; (2) further cooperation between intermediary banks and the broker-dealers they work for; and (3) greater availability of compliance products normally unavailable to broker-dealers because they are not “insured institutions.”

In response, the SEC assured the Working Group that under the described circumstances, it would not recommend enforcement action under Regulation E. The SEC’s position avoided any agreement with the analysis and conclusions that the Working Group provided.  Specifically, the SEC described that it would not recommend action enforcement action under the rule if a broker-dealer “provides to consumers disclosures of fees, currency exchange rates and taxes as though the broker-dealer was an ‘insured institution.’”

The primary materials may be found on the DU Corporate Governance Website.

XeDAR Corp. v. Rakestraw: Securities Fraud Claims Allowed Despite Covenant Not To Sue and Colorado’s Economic Loss Rule

In XeDAR Corporation. v. Rakestraw, No. 12–cv–01907–CMA–BNB, 2013 WL 93196 (D. Colo. Jan. 8, 2013), the United States District Court for the District of Colorado granted in part and denied in part XeDAR Corporation’s (“XeDAR”) motion to dismiss counterclaims of the Defendant, Don Rakestraw, for alleged fraud, negligent misrepresentation, violations of section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, breach of contract, and breach of fiduciary duty.

According to the allegations in the complaint,  XeDAR in 2007 acquired Rakestraw’s company, Point One LLC. The terms of the acquisition guaranteed Rakestraw 1,552,500 shares of XeDAR stock, and he received another 303,695 shares over the following four years as compensation for services provided to XeDAR.

In 2011, XeDAR started repurchasing shares from some of its shareholders. After learning about the stock repurchase, Rakestraw sought to ascertain the reason for the buyback. He spoke with Bob Johnson, the President of Pixxures, XeDAR’s revenue-generating subsidiary, who assured him that no companies were interested in acquiring XeDAR. Rakestraw also spoke with Hugh Williamson, XeDAR’s CEO and Chairman, who confirmed the buyback and referred him to XeDAR’s Controller, Dawn Patterson, who also assured Rakestraw that no company had expressed interest in acquiring XeDAR.

Based on these representations, Rakestraw sold his shares on March 8, 2012 at $0.17 per share pursuant to a Repurchase Agreement (“Agreement”). Fifteen days later, IHS Global, Inc. (“IHS”) delivered an “indication of interest” in acquiring XeDAR, and after five more days, IHS and XeDAR agreed to the acquisition. Consequently XeDAR’s share price rose to $0.88.

Believing he should have been informed about the negotiations, Rakestraw served XeDAR with a settlement demand letter. XeDAR filed a complaint seeking injunctive relief in state court. Rakestraw removed the case to federal court and asserted counterclaims.

XeDAR’s motion to dismiss was premised upon three arguments. XeDAR first asserted that the covenant not to sue in the Agreement Rakestraw signed barred his claims. The court disagreed, reasoning that the alleged fraud induced Rakestraw to enter into the Agreement and may be unenforceable. Further, the court found that the Agreement did not contain an “explicit disclaimer-of-reliance” in “clear and specific” language. In contrast to examples in prior case law, the covenant not to sue was a general “import” of the language and did not bar claims for intentional fraud.

Next, XeDAR argued Colorado’s economic loss rule precluded Rakestraw’s claims. The court again disagreed, reasoning that Rakestraw’s claims stemmed from an “independent duty of care . . .  owed by XeDAR,” as opposed to the contractual duty that would have been precluded by the rule.

Finally, XeDAR sought dismissal based on Fed. R. Civ. P. 12(b)(6), arguing that Rakestraw’s counterclaims were not sufficiently specific to meet the Iqball/Twombly plausibility standard. The court found Rakestraw’s fraud claims insufficient for three reasons: the timeframe between the allegedly false assurances given to Rakestraw and IHS’ indication of interest was at least “arguably suspicious,” intent to defraud could be reasonably inferred, and Rakestraw’s damages were adequately articulated. However, the court dismissed Rakestraw’s breach of contract claim because his allegations implicated conduct that occurred before the Agreement existed, and he received payment for his shares at the agreed upon price.

The court granted in part and denied in part XeDAR’s motion, granting dismissal of the breach of contract claim, but declining to dismiss the fraud claims.

The primary materials for this case may be found on the DU Corporate Governance website.

The Race to the Bottom and Student Posts

The Race to the Bottom is unusual in that, since its foundation in 2007, students have been very involved in the management and content of the Blog.  One noticeable example is that students sign on to the Blog after a writing competition then begin writing posts.  The posts go through edits by the student staff of the Blog and by faculty.  Students writing posts learn new areas of substantive law. 

Perhaps more importantly, they develop important writing skills.  The posts do not reflect a scholarly, law review style of writing.  The posts are written in a practical, accessible fashion that emphasizes brevity and clarity.  More than merely make this claim, we will provide the evidence.  For the next two weeks, we will publish student posts.